Judge Ada Brown of the U.S. District Court for the Northern District of Texas on Tuesday struck down the Federal Trade Commission’s (FTC) pending ban on non-compete covenants, concluding that the issuance of the FTC’s Rule (“the FTC Rule”) exceeded the FTC’s authority. As a result, the FTC Rule will not go in effect on September 4, 2024.

The Texas Ruling

In a 27-page opinion, the court issued a sweeping blow to the FTC, finding that: (1) the FTC exceeded its statutory authority in issuing the FTC Rule; and (2) the FTC Rule was arbitrary and capricious because it is unreasonably overbroad without adequate justification.

The court reasoned that “the text and structure of the FTC Act reveals that the FTC lacks substantive rulemaking authority with respect to unfair methods of competition” and that the FTC Rule is a substantive rule.

The court further concluded that the rule should be set aside under the arbitrary and capricious standard used for judicial review of administrative actions because it utilizes a “one-size-fits-all approach,” and the FTC failed to provide adequate evidence to support the sweeping prohibition.

The court also noted that the FTC failed to consider the benefits of non-compete covenants, disregarding a body of evidence supporting their use. The FTC also failed to consider adequate potential alternatives to a broad prohibition.

In granting summary judgment, the court looked to the Administrative Procedure Act (APA), which permits a court to hold unlawful and set aside improper agency actions. Although the FTC argued that any relief should be limited to the parties to the proceeding, the court concluded that “the APA does not contemplate party-specific relief,” and, as such, the ruling would apply nationwide.

What is Next?

It is expected that the FTC will appeal the ruling to the U.S. Court of Appeals for the Fifth Circuit, and the trajectory of any appeal may depend on results of the upcoming presidential election. Some predict that a Trump victory would result in the FTC withdrawing the appeal. Under a Harris presidency, an appeal would be more likely to go forward, where it would ultimately face an uphill battle before a conservative majority Supreme Court.

In the meantime, companies may (where state law permits) continue to use narrowly-tailored non-compete covenants. As we previously reported, many states including California, Colorado, Illinois, North Dakota, Oklahoma, Massachusetts, Washington DC, Oregon, Minnesota and Washington, already ban or heavily restrict the use and administration of non-compete covenants. Companies with employees and contractors in states where non-compete covenants are banned or heavily restricted must carefully review their restrictive covenant agreements for compliance with state law and consider whether to shift their focus to confidentiality and non-solicitation agreements to protect their confidential information, business relationships and their investment in their workforce.

Quarles will continue to monitor the status of the FTC Rule and non-compete related developments at both the state and federal level, including the continued legal challenges that will likely play out over the next year or longer.